Question 5 b. Rowan Salam = RM54.60 Salmah = RM50.40 Salmi = RM61.88 c. Piecework Scheme Salam = RM102.50 Salmah = RM202.50 Salmi = RM110.50 Question 6 Worker A = RM23.04 Worker B = RM34.56 Question 7 Employee A - Total earnings RM117.60 Employee B - Total earnings RM153.60 ANSWER'S GUIDE 45
CHAPTER FOUR COSTING FOR OVERHEADS learning outcome : Identify the concept and how direct expenses trace to products. Explain classification of overhead, production and service departments. Distinguish between allocation overhead, apportionment and 1. 2. 3. reapportionment overhead. 4.Explain the overhead absorption rate and methods. 5.Calculate overhead or predetermined absorption rates - one rate for one department and one rate for several departments. 6.Calculate over or under absorption of overhead. 46
4 . 1 THE CONCEPT OF DIRECT COST TO PRODUCT CIMA, defines overhead as “Expenditure on labour, materials or services which can not be economically identified with a specific saleable cost unit”. Direct cost can be directly identified with a cost centre or cost unit. In other word, it can be allocated directly to the product while indirect costs are apportioned expenditure because it cannot be trace directly to the cost centre but contribute to the company operational activities as a whole. 47
Direct costs are costs traceable to a particular product or service. For example, in a bakery shop, flour, butter and sugar used in baking bread is direct materials cost to the production of bread. Wages paid to baker, machine operator and cake decorator are direct labour cost. This cost can be easily identified to the product. Therefore the whole items of direct cost are allocated to the product. DIRECT COST 48
Indirect costs are “those which are incurred for common or joint objectives and therefore cannot be identified readily and specifically with a particular cost unit/cost centre. A few examples of such expenses are rent, insurance, depreciation, repairs and maintenance, fuel and lighting. INDIRECT COST In a bakery shop, making and baking are PRODUCTION COST CENTRES while administration, information technology, stores and accounts are SERVICE COST CENTRES. 49
Classification of overheads refers to the process of grouping costs according to their common characteristics. C L A S S I F I C A T I O N O F O V E R H E A D 4 .2 50
CLASSIFICATION OF OVERHEAD Overhead can be classified into 5 category, which is by nature, function, behaviour, controllable and normality. 51
INDIRECT MATERIALS O V E R H E A D B Y N A T U R E INDIRECT LABOR INDIRECT EXPENSES Examples: Electricity, deprecation of machine, insurance, canteen, taxes, rates and rent. Examples: wages of foreman, maintenance and repair work. Examples: nuts, screws, glue, fuel, lubricants. 52
O V E R H E A D B Y F U N C T I O N 53
O V E R H E A D B Y B E H A V I O U R Example: Rent, Insurance, maintenance, depreciation Example: Indirect materials, Electricity, Water, Telephone Charges, Overtime Premium. Example: Electricity, Telephone Charges, Sales Commision. 54
O V E R H E A D B Y C O N T R O L Expenses which can be controlled by the management through the efficient use of resources like Idle Time wastages. Costs which is not under the control of management. All fixed expenses are uncontrollable costs. CONTROLLABLE COST UNCONTROLLABLE COST 55
O V E R H E A D B Y N O R M A L I T Y 56
ACTIVITIES In group of 4, choose any business or industry. Identify overhead cost in the business or industry chosen. PRESENT YOUR FINDINGS IN CLASS 57
ALLOCATION, APPORTIONMENT AND REAPPORTIONMENT OVERHEAD Direct Method Step Down Method Reciprocal Method 4 . 3 58
ALLOCATION AND APPORTIONMENT OVERHEAD ANALYSIS Overhead cost comprises indirect material, indirect labour and indirect expenses. Since overheads cannot be trace directly to the cost units as fairly and as accurately as possible, an overhead analysis needed to determine the overhead cost for each cost centre. This is achieved through the process of allocation and apportionment. Cost allocation is possible when we can identify a cost as specifically attributable to a particular cost centre. Cost apportionment is necessary when it is not possible to allocate a cost to a specific cost centre. In this case the cost is shared out over two or more cost centres based on suitable basis. 59
According to the Chartered Institute of Management Accountants, cost allocation is “that part of cost attribution which charges a specific cost to a cost centre or cost unit”. COST ALLOCATION According to the Chartered Institute of Management Accountants, cost apportionment is “that part of cost attribution which shares costs among two or more cost centres or cost units in proportion to the estimated benefit received, using a proxy”. COST APPORTIONMENT 60
ALLOCATION As the amount incurred is not traceable to each unit of production in a direct manner, overhead cost will be allocate using either direct method, step down or reciprocal method. Allocation involves charging overheads directly to specific departments (production and service). 21 36 61
ALLOCATION As the amount incurred is not traceable to each unit of production in a direct manner, overhead cost will be allocate using direct method or step down method or reciprocal method. Allocation involves charging overheads directly to specific departments (production and service). 21 36 62
O V E R H E A D A L L O C A T I O N Example 1: Anggun Bergaya Manufacturing has two service departments and two production departments as shown below: The two service departments provide service to production departments. The service department cost is to be allocated to production department on the basis of employee. Required: Allocate the cost of service departments to operating departments using direct method of cost allocation. ANSWER EXAMPLE 1 63
ADVANTAGES AND DISADVANTAGES 64
O V E R H E A D A L L O C A T I O N Example 2: Selendang Merah Manufacturing has two service departments and two production departments as shown below: The two service departments provide service to each other as well as to production departments. The service department cost is to be allocated to others department on the basis of square feet of space occupied. Required: Allocate the cost of service departments to operating departments using step down method of cost allocation. 65
ANSWER EXAMPLE 2 66
ADVANTAGES AND DISADVANTAGES 67
RECIPROCAL METHOD T h e r e c i p r o c a l m e t h o d u s e s s i m u l t a n e o u s e q u a t i o n s t o a l l o c a t e t h e c o s t s i n c u r r e d b y s e r v i c e d e p a r t m e n t s t o o t h e r d e p a r t m e n t s . O V E R H E A D A L L O C A T I O N Although it is the most accurate, it is also the most complicated. 68
SECONDARY DISTRIBUTION PRIMARY DISTRIBUTION Primary distribution involves apportionment or allocation of overhead among all department in the factory in suitable basis. OVERHEAD APPORTIONMENT Overhead cost which can directly identified with a particular department or cost centre can be allocated specifically to the department. However, some overhead cost for example electricity, rents and insurance cannot be identified and charged directly to the department. So the cost must be apportioned to the department utilizing that overhead cost. This is call primary distribution overhead. The second step is to distribute the total cost of service departments among the related departments. 69
SECONDARY DISTRIBUTION OVERHEAD RE-APPORTIONMENT The second step is to distribute the total cost of service departments among related departments. DIRECT METHOD Overhead cost of service department distribute to the production department only. STEP DOWN METHOD Overhead cost of service department distribute to production department and the another service department only. RECIPROCAL METHOD Overhead cost of service department distribute to production department and inter service department. Reciprocal Method also known as Continuous Method. 70
A P P O R T I O N M E N T B A S I S Suggested basis of apportionment of overhead cost among department. APPORTIONMENT BASIS FOR SERVICE DEPARTMENT APPORTIONMENT BASIS FOR OVERHEAD COST Suggested basis of apportioning the service department costs to the production departments. 71
Example 3: Selendang Merah Manufacturing has two service departments and two production departments as shown below: Electricity : RM60,000. Rent : RM50,000. The total floor area of the building: 25,000 square metres. The Assembly Department covers up to 10,000 square metres. The Maintenance Department covers up to 5,000 square metres. Required : Calculate overhead cost apportionment to the Assembly Department and the Maintenance Department using floor area basis. ANSWER EXAMPLE 3 72
Example 4: Menjadi Sdn Bhd has two production departments, Grinding and Mixing and two service departments, Maintenance and Purchasing. Both service department give service to the production departments. The overhead costs for Menjadi Sdn Bhd in total are as follows: Overheads cost RM Rent and rates 30,000 Power 12,000 Insurance for building 2,000 Depreciation of the machinery 6,000 There are also costs that have been allocated directly to the departments: RM Grinding Department 7,000 Mixing Department 8,000 Maintenance 5,000 Purchasing 2,000 The following information are related to overhead cost of Menjadi Sdn Bhd: You are required to allocate and apportion the overhead costs on the following bases: (a) Rent and rates, insurance on building – Floor areas (b) Depreciation on machinery – Machine value (c) Power usage 73
ANSWER EXAMPLE 4 74
Example 5: The following data cost are extracted from Synergy Manufacturing: The expenses of service department’s charged out on a percentage basis as the following: You are required to show the reapportionment of overhead using reciprocal method @ continuous method: 75
ANSWER EXAMPLE 5 76
CIMA DEFINES ABSORPTION OF OVERHEADS AS “THE PROCESS OF ABSORB, OVERHEAD COSTS ALLOCATED OR APPORTIONED OVER A PARTICULAR COST CENTRE OR PRODUCTION DEPARTMENT BY THE UNITS PRODUCED”. OVERHEAD ABSORPTION 4 . 4 77
Production overheads are recovered by absorbing them into the cost of a product and this process is therefore called absorption costing. Single rate of overhead absorption (OAR) or called ‘plant-wide’ incorporates all the overheads chargeable and consumed by the production. The base rate or overheads rate for absorption may be historical or predetermined. ABSORPTION RATE AND METHOD Overhead Absorption Rate (OAR) formula. 78
ABSORPTION RATE BASIS Overhead Absorption Rate (OAR) formula. 79
ABSORPTION RATE BASIS Overhead Absorption Rate (OAR) formula. 80
Example 6: Top Disposable Glove Sdn Bhd estimates to produce 20,000 units of Medical Glove type AAA and the standard production overheads for the next month is estimated to be RM100,000. What is the overheads absorption rate based on the standard number of units to be produced? Answers: Overheads absorption rate (OAR) = RM100 000 20,000 units = RM 5 per unit Each unit of Medical Glove type AAA produced absorbed RM5 of overheads. In order to use this method, the product must be identical or similar. Example 7: Top Disposable Glove Sdn Bhd produce Medical Glove type AAA, with expected overheads cost of RM600,000 per annum. The estimated of labour hours worked in the department is 300,000. i. What is the overheads absorption rate per labour hour? ii. If it takes 2 hours to produce 1 unit of Medical Glove type AAA, what will be the amount of overheads charged to Medical Glove type AAA ? Answers: i. Overheads absorption rate (OAR) = RM600 000 300,000 = RM2 per labour hour ii. Production Overhead charged for each unit of Medical Glove type AAA = 2 hours × RM2 per hour = RM4 per unit 81
Example 8: Proton Bhd produce X70 with expected overheads cost of RM500,000 per annum. The estimated of machine hours used in the department is 200,000. What is the overheads absorption rate per machine hour? Answers: Overheads absorption rate (OAR) = RM500 000 200,000 = RM2.50 per machine hour 82
P R E D E T E R M I N E O V E R H E A D A B S O R P T I O N R A T E 4 .5 83
Usually computed at the beginning of each period by dividing the estimated manufacturing overhead cost by an allocation base (also known as activity base or activity driver). The overhead applied to products or job orders would, therefore, be different from the actual overhead incurred by jobs or products. PRE DETERMINE OVERHEAD ABSORPTION RATE A predetermined overhead rate is an allocation rate that is used to apply the estimated cost of manufacturing overhead to cost objects for a specific reporting period. Activity level are base on basis same as apportionment basis. Example: Direct Labour Hours, Direct Machine Hours And Unit Of Output. 84
Example 9: Pfizeria Manufacturing has collected the following budgeted data: Production overheads RM50,000 Direct Labour Hours 1,000 hours Direct Labour Cost RM5,000 Machine Hours 10,000 hour Direct Material Cost RM2,000 Production output 2,500 units Calculate OAR using the following bases: a) Direct Labour Hours b) Direct Labour Cost c) Machine Hours d) Direct Material Cost e) Production output Answers: 85
UNDER OR OVER 4 .6 ABSORPTION When predetermined overhead rates are applied, the overheads absorbed will be greater or lesser than the actual expenditure incurred on the account of overheads. UNDER ABSORP OVER ABSORP If the absorbed amount is lesser than the actual overheads incurred, it is call under absorption. If the absorbed amount is greater than actual incurred, it is call over absorption. Such over or under-absorption may also be termed as overhead variance, the amount of over-absorption being represented by the credit balance on the variance account, and, conversely, the amount of under- absorption by a debit balance. Formula for overheads absorption as the following: 86
Example 10 Mirror Sdn Bhd manufactures Product R. The following budgeted and actual data relate to production activity and overheads of the product: Budget Actual RM RM Production overheads 300,000 250,200 Direct labour hours 60,000 83,000 The company uses an absorption costing system and production overheads are absorbed on a direct labour hour basis. Calculate the total overheads absorbed in the productions. Show over or under absorbed overheads. Answers: 87
You are required to show the apportionment of overhead using I. Direct method II. Step down method III. continuous /reciprocal basis The expenses of service departments charged out on a percentage basis as the following: Review Questions Chapter Four QUESTION 1 The following data cost are extracted from True Beauty Manufacturing: Production Department Service Department 88
You are required to: a. Prepare a statement showing the overhead cost apportionment for each department, showing the basis used. b. Calculate suitable overhead absorption rates (OAR) based on direct labour hour. Review Questions Chapter Four QUESTION 2 Sun Shine Manufacturing has three production departments (X, Y and Z) and two service department (M and N). Overhead costs incurred for the month of July are follow: All department are in the same premises. Other’s information related to the factory are as follow: 89
You are required to: a) Prepare a statement showing the overhead cost apportionment for each department, showing the basis used. b) Calculate overhead absorption rates (OAR) based on direct labour hour. The overhead cost of service department allocated to others department as follow: Review Questions Chapter Four All department are located in the same premises. The following data are available: QUESTION 3 Astro Technology Sdn Bhd has two production department, Machining and Finishing and two services department, Store and Account. Overhead costs incurred for the month of March 2021 are follow: 90
Review Questions Chapter Four QUESTION 4 Doremi Ltd. operates 3 production departments which is K, L and I and 2 service department which is A and B. Overhead cost for the year were as follows: Additional information as follow: 91
Overhead absorption rates used from previous financial year were as follow: K: 50% on departmental direct labour cost L: RM2.00 per machine hour I: RM0.70 per direct labour hour You are required to: a) Prepare an overhead analysis sheet showing the distribution of overhead cost to the departments. b) Show over/under absorption of overhead during the year. Review Questions Chapter Four The cost of service departments, A and B are allocated to other departments on percentage basis: 92
Required: a)Prepare Overhead Cost Statement (18 marks) b)Calculate overhead absorption rate based on labour hour. (7 marks) Review Questions Chapter Four Additional Information: Other cost to be apportioned to departments based on appropriate basis: Rent RM120,000 Insurance of Machine RM 20,000 Canteen expenditures RM 32,000 Electricity and power RM 15,000 QUESTION 5 (FINAL EXAM JULY 2006) Nilam Purnama produced silk in Kota Marudu, generate 3 departments to distribute their overhead namely Sutera Idaman, Sutera Harapan and Sutera Gemilang. The following are the allocated costs: 93
You are required to: a) Prepare Overhead Analysis Statement to 5 cost centres. b) Distribute the service cost centre cost among the production cost centres. c) Calculate the overhead absorption rate for three production department. Review Questions Chapter Four It is decided that the overheads should be apportioned to cost centres by percentage as follows: QUESTION 6 (FINAL EXAM JAN 2009) Syarikat Edenlife Sdn Bhd has five cost centre-three production department and two service department. Budgeted manufacturing overhead for the company beginning 1 January 2003 is as follow: Overhead to be apportioned: (RM’000) Insurance Building 60 Insurance Machine 180 Depreciation Machine 900 Rent and Rates 300 Power 120 Electricity 120 1,680 94